Caveat Loans: Tips and Traps

As the cost of buying a home keeps rising, many first home buyers are turning to their parents to help them financially to get into the market. These loans, from the Bank of Mum and Dad, are sometimes called caveat loans.

The idea behind a caveat loan is that it provides finance from the parent to their child, but which is not secured against the purchase property. Unlike a traditional mortgage from a bank, a caveat loan offers the buyer quick access to funds, without the stringent bank approval process and may avoid the need for bank approval to register a second mortgage.

The process involves the parties signing a loan agreement, followed by the parents registering a caveat against the property, after the bank registers its mortgage.  A caveat acts as a warning to anyone that the parents are owed money arising from the loan.

While caveat loans can provide first-home buyers a leg-up into the property market, there are inherent risks, which need to be carefully considered. These risks include the following:

1. Legal Complexity: Caveat loans can be complex and require careful consideration. Clear documentation outlining the terms of the loan is crucial to avoid disputes in the future. Without proper documentation, it may be difficult for parents to recover their loan. Unlike mortgage-backed loans, caveat loans do not ensure repayment and does not give the lender the power to sell the property to recover their loan.  If parents want the power to sell the property, they should consider taking a mortgage.
2. Family Law Considerations: Parents need to decide if they intend to treat the money as a gift or a loan. If they intend to treat it as a loan, is the loan solely to their child or to their child’s spouse as well? If the loan is not repaid, does the parent intend to enforce it? If the child separates from their spouse, consideration must be given to how the loan will be treated. A mortgage may carry greater weight in the eyes of the Family Court. Poorly considered loan documents could cost both parents and their children hefty legal fees to enforce the loan.
3. Bank considerations: Many banks want the parents (lenders) or the children (borrowers) or both, to sign a declaration that the amount the parents provide is a gift and not a loan.  Great care needs to be taken by parents when navigating the bank’s requirements for the children’s loan.  The money parents provide cannot be both a loan and a gift.  Carelessly signing bank documents can make it difficult or impossible for parents to later recover the money they have advanced.  Also, a caveat loan may breach the bank’s lending rules and the bank loan and mortgage documents the children later sign.
4. Inheritance considerations: If the recovery of the loan is not achieved through the Court, proper estate planning can be used as a tool to ensure fairness and equity between the lenders’ children, by taking the loan into account when distributing their estate after death. Legal advice should be sought to avoid ambiguity or uncertainty, otherwise the provision in the will dealing with this issue may not be enforceable.
5. Property Market Volatility: A downturn in the property market may leave borrowers owing more than the property is worth and parents may not recover their loan, or a part of it, after the bank has been paid out.
6. Financial Stress: Parents dipping into their savings to help their children may put their own financial security at risk. Poor planning can strain family relationships.

While caveat loans and assistance from the Bank of Mum and Dad can offer valuable support to children, careful planning is required to mitigate these risks. This includes:

1. proper drafting of loan agreements and security documents;
2. considering what pre-conditions to the loan must be met by the child before advancing funds, e.g. entering into a binding financial agreement with their spouse;
3. ensuring the conditions of repayment are achievable and realistic;
4. taking appropriate mortgage security over the property, or a caveat;
5. ensuring parents and children clearly understand the loan and security terms; and
6. understanding the procedures and limitations of enforcing the loan.

If you are intending to either gift or loan money to your child, or if you have already lent money to your child, and you are seeking to enforce the loan, we strongly recommend that you:

• seek professional advice from an independent financial advisor, mortgage broker, and lawyer experienced in dealing with such loans who can provide invaluable insights into the implications of caveat loans and family financial arrangements
• have open and honest communication with your child and their spouse regarding each party’s expectations and obligations to prevent misunderstandings and conflict
• conduct financial due diligence to assess the feasibility of loan repayments and prepare for unforeseen circumstances.

While caveat loans and the Bank of Mum and Dad can offer a pathway to property ownership, they necessitate cautious navigation. By understanding the associated risks and planning for them, families can minimise potential conflict and pave the way for a more secure financial future.

If you have any questions or seek legal advice on caveat loans or the bank of mum and dad, please contact our experienced team of lawyers.

Important Disclaimer: The content of this article is general in nature and for reference purposes only. It does not constitute legal advice and should not be relied upon as such. Legal Advice about your specific circumstances should always be obtained before taking any action based on this publication.